Caterpillar Proves Deflationary Period is Alive and Well

I used to love seeing Caterpillar equipment. It made me think of how much fun it would be to drive around on a crane, or excavator, or whatever all those other big machines are called.

Then I got a little older. I still want to drive those machines around, but now I hate to see them. Since I started driving, I associate Caterpillar equipment with road construction and traffic snarls. Whenever I see the familiar black and gold painted earth movers next to the road, I know traffic in that area will be ugly for weeks to come. Ugh.

Now here comes Caterpillar to make one more association for me – and it’s deflationary. All because its unionized workers strike… regularly…

Back in February 2009, the equity markets were plunging. Caterpillar was no different. Its stock fell from the mid $80s down to just over $23 per share.

However, the company never reduced its dividend, continuing to pay over $0.40/per share quarterly. And it continued to point out the incredible international demand for its products.

As you might expect, the shares of the company came roaring back, even surpassing its 2008 high. Recently it reached over $110/share. Today, it’s sitting around $95/share.

In the most recent quarter, Caterpillar reported $1.6 billion in earnings on $16 billion in revenue. Not too shabby!

So what does the growth of a large company with stable dividends and great earnings have to do with being deflationary? It’s all in the wages… or should I say, the U.S. wages…

A Hallmark of Deflation

Recently the workers in the International Association of Machinists and Aerospace Workers Union at the Joliet, IL Caterpillar plant renegotiated their contract. The company wanted to scuttle a pension plan, have more flexibility in hiring temporary workers at greatly reduced wages, have the ability to freeze workers’ pay for six years, and require the workers to pay more in healthcare costs.

Now, given the profitability of the company, its robust earnings and great sales, you might find it odd that it’s playing hardball when it comes to negotiating with their workers. Why is it doing it then? The short answer is, “Because it can.”

Labor is an input. It is one of the components that makes a company go. When labor is in short supply, meaning there are too few workers to fill the jobs available, then wages and benefits go up to attract more people.

The inverse is also true. When labor is plentiful, when there are too many people for the number of jobs available, then wages and benefits fall.

Today, companies hiring know all too well that there are many more job applicants than there are jobs, so wages remain under pressure. In fact, wages are even falling on an inflation-adjusted basis.

Falling wages are a hallmark of deflation… and we have it in spades.

Take It or Leave It

The interesting point here is that companies adjusted to the economic downturn very quickly. Some companies, like Caterpillar, supply the growth in developing nations like China, so they experience less of a decline.

Part of the economic adjustment in the U.S. was the firing of millions of workers. This allowed companies to match their costs to their sales, thereby returning to profitability rather quickly. But it left the unemployed out in the proverbial cold. So, as new employees are hired, or existing contracts come up for renewal, companies can be very stingy.

The outcome of this situation is long term and it’s ugly.

As workers earn less, they can afford less. So consumer spending falls. And tax revenue at the local and national level fails to recover without additional taxes being tacked on.

The end result is that we get a short burst of profits and positive earnings surprises from Corporate America, but eventually the deflationary pressures come back to haunt them. The population and the businesses in a country can’t travel different roads for very long.

Rodney

P.S. While Caterpillar is taking a harder line with its American workforce, the company is fundamentally sound, especially because of its infiltration into markets around the globe. In fact, it is one of the five corporate El Dorados we believe will dominate the new economic order that will arise from this deflationary downturn. We explain, in detail, in our Shakeout Winnersreport.

Ahead of the Curve with Adam O’Dell

If Charts Could Talk

This chart of Caterpillar tells a great “before and after” story. It’s also a textbook example of “resistance, once broken, becoming support.” That’s technical analysis speak, so let me explain… Caterpillars stock…

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.